State and local tax deduction not as valuable as it seems

Speaker of the House Paul Ryan (R-WI) leaves a press conference following a weekly meeting of the House Republican caucus on Tuesday in Washington. House Republicans’ tax bill would do away with the deduction for state and local income or sales tax, but let itemizers deduct up to $10,000 in property taxes.

Speaker of the House Paul Ryan (R-WI) leaves a press conference...

The itemized deduction for state and local taxes has become a flash point in the debate over the GOP’s tax plans.

The House and Senate proposals call for sharply limiting or eliminating the so-called SALT deduction. Critics say Republicans in high-tax states would have a hard time voting for any bill that included this provision, because the deduction is so valuable to their constituents.

And it is, to some. But many people in high-tax states get no benefit from this deduction because they don’t itemize deductions or they are subject to the alternative minimum tax, which doesn’t allow it. Another group of people get little benefit because they are subject to the phaseout of all itemized deductions that kicks in at higher incomes.

A study published Tuesday by the Institute on Taxation and Economic Policy predicted that four states including California “would see their residents pay more in aggregate federal personal income taxes under the House’s Tax Cuts and Jobs Act,” largely because it would “dramatically curtail” the SALT deduction. But that doesn’t mean everyone in California would be hurt by the loss. Here’s a closer look at three groups for whom it would not matter much, if at all.

More by Kathleen Pender

Non-itemizers: Many low- and middle-income people get no benefit from the SALT deduction because they don’t itemize deductions. They take the standard deduction because it’s higher. Both the House and Senate tax proposals would increase their ranks by roughly doubling the standard deduction to $24,000 for married couples filing jointly and $12,000 for single filers. The Tax Policy Center estimates this would reduce the share of all tax filers who itemize to less than 10 percent from about a third today.

AMT subjects: Some people, mostly upper-middle-income, get no benefit from the deduction because they are subject to the alternative minimum tax. Under the AMT, state and local taxes — including income, sales and property taxes — are not deductible. Most people who owe AMT earn around $200,000 to $500,000. In California, about 5 percent of all tax returns paid AMT. Only New Jersey, Washington, D.C., Connecticut and New York had a larger percentage.

Pease people: Some high-income people who itemize deductions and are not in the AMT lose some of the deduction through what’s known as the Pease limitation. This provision eats away at a taxpayer’s itemized deductions — including the one for state and local taxes — once taxable income hits $330,000 (married filing jointly) or $266,700 (single filers). It can devour up to 80 percent of itemized deductions.

Both the House and Senate versions of the GOP tax bills would repeal the AMT and the Pease limitation.

The Senate version would do away with the state and local tax deduction entirely. The House version would do away with the deduction for state and local income or sales tax but let itemizers deduct up to $10,000 in property taxes.

In California, about 34 percent of 2015 tax returns claimed a SALT deduction, and the average among those who did was about $18,400. These often-cited numbers overstate the benefit of the deduction because they include people who claimed the deduction on their return but lost all or part of it because of the AMT or Pease limitation.

The interactions among the AMT, SALT and Pease limitation “have generated considerable confusion, as it can appear that certain taxpayers would ‘lose’ the state and local tax deduction when, in fact, they cannot claim it under current law due to the AMT, or can only claim a portion of it due to the Pease limitation,” the Tax Foundation, a research organization, said in a blog post.

For people subject to AMT, killing the AMT and SALT deduction could result in higher, lower or roughly the same taxes, depending on their individual circumstances and other provisions in the tax proposals. Here’s why:

All taxpayers are required to figure out their taxes under the regular tax system and the alternative system and pay whichever is higher. Under the regular system, there are seven tax brackets, topping out at 39.6 percent. The AMT allows fewer deductions and has only two tax brackets, 26 and 28 percent.

The highest-income people generally do not pay AMT because their regular tax rate, 39.6 percent, is so much higher than 28 percent.

When people are subject to the AMT, it shows up on their tax return as an addition to their regular tax.

In June, the Brookings-Urban Tax Policy Center estimated what would happen if Congress killed the SALT deduction and the AMT. It found that nearly three-quarters of AMT filers would pay higher taxes, mainly because their regular tax without the SALT deduction would be higher than their AMT. The other quarter would see a tax cut.

This analysis, however, did not factor in a cut in regular tax rates. Both the House and Senate tax bills would cut marginal tax rates for most taxpayers, which probably would reduce the percentage of AMT filers who might get hurt by the loss of the SALT deduction.

The center did not estimate how the bills would affect people currently subject to AMT. But it did estimate the impact of the original House bill on taxpayers in general and found that in 2018, about 76 percent would get a tax cut and 7 percent would get a tax increase. For people in the top 95th to 99th income percentile, 6 percent would get a tax increase. Those tend to be AMT people, said Frank Sammartino, a senior fellow with the center.

The Tax Foundation had a different take. “For taxpayers denied the SALT deduction currently, replacing the overall deduction with a capped property tax deduction, paired with the repeal of the AMT and the Pease limitation, actually represents a modest benefit, not a loss,” it said in a blog post.

Bottom line, take what you hear about the state and local tax deduction with a grain of salt.